Proposed Delta-Northwest Merger Raises Questions for Airline Industry

April 15, 2008 at 6:05 PM EST

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A proposed Delta-Northwest airline merger comes at a tumultuous time for an airline industry facing high fuel prices and questions over safety procedures. An airline analysts describes the possible implications of the mega-merger and whether consumers will benefit.

JUDY WOODRUFF: The Delta-Northwest deal comes at a tumultuous time for the airline industry. Fuel prices are soaring; demand is slow; and thousands of flights were cancelled last week due to missed inspections.

But by combining operations and extending travel routes, Delta and Northwest say they hope to save $1 billion a year by 2012. The deal still requires approval by the U.S. Justice Department.

For more, we are joined by Philip Baggaley. He’s a senior airline credit analyst with Standard and Poor’s.

Thank you for being with us. Both of these airlines came out of bankruptcy just last spring. Why do they want to merge?

PHILIP BAGGALEY, Airline Credit Analyst, Standard and Poor’s: Well, the situation has deteriorated. Last year, when they came out of bankruptcy, the airline outlook looked quite bright, really.

At this point, as you mentioned, fuel prices are much higher; demand is slowing; and they feel they need to do something to counteract that.

Merging to cut costs

Philip Baggaley

Standard and Poor's

They hope to cut some overhead costs, remove duplicate headquarters, computer systems, and so forth. So between the two of those, they're expecting both revenue and cost gains.

JUDY WOODRUFF: How, by coming together, do they counteract high prices of fuel?

PHILIP BAGGALEY: Well, of course, they can't undo the high fuel prices. What they're trying to do is generate more revenues by putting together a broader route network.

Delta is strong in the south and the east and to Europe. Northwest is strong in the Midwest and across the Pacific. Put it together, you have a more attractive product for business travelers.

Also, they hope to cut some overhead costs, remove duplicate headquarters, computer systems, and so forth. So between the two of those, they're expecting both revenue and cost gains.

JUDY WOODRUFF: But didn't they also say today that they don't expect at this point to cut down on airline hubs and they don't expect to cut any additional employees?

PHILIP BAGGALEY: Well, both airlines had actually said that later this year they will be reducing their capacity in the domestic market, which is a process they've already been doing. They did say they would not be closing any hubs.

They didn't say, though, that they might not shrink some or reallocate flying between one to another to try to optimize it within a broader route network. So I think there could be some changes, but not necessarily dramatic ones.

JUDY WOODRUFF: Philip Baggaley, is this going to be better for consumers? Are fares going to go down?

PHILIP BAGGALEY: Well, frankly, I doubt that fares are going to go down no matter what happens, unless the price of jet fuel drops dramatically. Either the airlines that are currently out there will succeed in raising fares so they can cover those costs or else some airlines will go bankrupt and eventually shut down, in which case later on they'll be able to raise costs or possibly, in a merger, they'll have somewhat greater pricing power.

But at these economics, they can't really afford to charge the fares they have now.

Justice, unions potential obstacles

Philip Baggaley

Standard and Poor's

The unions can't block a merger, but they can make life very difficult. In order to run the airline efficiently as a merged entity, they'll have to sign new contracts, bring the labor groups together.

JUDY WOODRUFF: As we were reporting, this is not a done deal. What are the prospects that this is going to go through to completion?

PHILIP BAGGALEY: Well, the main hurdle is the U.S. Department of Justice and they would be looking at it on antitrust grounds, that is, competitive concerns.

The two airlines actually have very little overlap, so that's something working in their favor. Now, it's also true this is an election year. And by the time they're coming into a decision later this year, we'll be in the middle of elections.

Airline mergers are very controversial, hot topic. So it's still an open question.

JUDY WOODRUFF: And how large a problem is the objection still of the two Northwest unions that are holding out?

PHILIP BAGGALEY: Well, the unions can't block a merger, but they can make life very difficult. In order to run the airline efficiently as a merged entity, they'll have to sign new contracts, bring the labor groups together.

They had earlier tried to do that with the pilots, but they were only partly successful, signing a contract with Delta's pilots. So the employee groups, if they're unhappy, can make life very difficult, but they can't actually block the merger.

More mergers to follow

Philip Baggaley

Standard and Poor's

If there is a Delta-Northwest merger, it probably won't be the last one. In fact, I think we could well see an announcement about a United-Continental merger in the not-too-distant future. So you could see a more consolidated industry.

JUDY WOODRUFF: What do you see as the impact on the rest of the domestic airline industry with all the competition from these budget airlines?

PHILIP BAGGALEY: Well, first of all, if there is a Delta-Northwest merger, it probably won't be the last one. In fact, I think we could well see an announcement about a United-Continental merger in the not-too-distant future. So you could see a more consolidated industry.

That said, that's not necessarily bad for the low-cost carriers. They still have much lower costs, simpler route systems, and they can compete effectively.

In fact, if the mergers raised fares somewhat and if they raised the labor costs, which they probably will in order to buy the cooperation of the labor groups in those merged airlines, with those higher costs and higher fares, the low-cost carries can compete more effectively.

JUDY WOODRUFF: And what about internationally, what do you see as the impact?

PHILIP BAGGALEY: Well, I don't really see a large impact. It's true that this will continue the process where these global alliances, the SkyTeam or the Star Alliance, are coming more closely together.

But the main obstacle to further consolidation in the global airline industry is the U.S. ownership laws. A foreign entity cannot own more than 25 percent of the voting power of a U.S. airline.

Now, the Europeans would like to change that, but there's a lot of opposition from U.S. unions and from many in Congress. That's probably the last big obstacle to broader mergers across borders.

JUDY WOODRUFF: Very quickly, I want to come back to something we mentioned earlier, and that is the head of Delta saying a main factor here was doing this to address the rising cost of fuel oil, and then we heard Congressman Oberstar saying he didn't see how that could be a reason for this.

How do you read that?

PHILIP BAGGALEY: Well, I don't think it's a direct response in that they can be somehow more fuel-efficient. I think it's an indirect response, in the sense that they would like to do something to generate higher revenues, cut their costs elsewhere, and thereby be able to survive the high fuel prices more effectively.

JUDY WOODRUFF: All right, well, we'll leave it with that. Philip Baggaley with Standard and Poor's, thanks very much.

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